We Should All Be On Supply’s Side

2013 September 26

by dan bertolet

With the latest reports of surging housing prices in Seattle, affordable housing is once again a hot topic in wonkland. Both the Mayor’s office and City Council have recently convened committees to explore affordable housing strategies, but unfortunately these efforts are largely focused on approaches that place the burden of providing affordable housing on new development. The problem is that exacting additional fees on new buildings discourages development and increases the cost of production, both of which run counter to the original intent of making housing more affordable.

If Seattle aspires to be truly progressive on affordable housing—and hopes to avoid the fate of insanely priced cities like San Francisco—a serious reassessment is in order, a key component of which must be proper consideration of the housing supply side.

First of all, it cannot be overstated that creating new multifamily housing in Seattle’s urban centers is a public benefit in itself. That a sustainable future depends on concentrating growth in dense urban centers is arguably the most agreed upon and defensible concept in the history of modern urban planning. That means when housing sites are developed below their potential in places like Seattle’s South Lake Union urban center, it’s a 50 to 100 year lost opportunity.

The stupid simple reason the supply side matters for affordability is that increasing housing supply puts downward pressure on prices. This relationship can be obscured, because in growing, high-demand cities prices may rise even as gobs of new housing is built, as is currently the case in Seattle. But despite claims that housing gets a magical exemption from basic principles of economics, it is an indisputable fact that housing prices are heavily influenced by supply and demand, as is verified over and over again by direct experience, e.g:

“More buyers and a limited supply of available homes have lifted prices in most cities across the country…”

“Whitworth manager Chris Garvin said the increases … are reflective of a high demand/low supply rental market in Capitol Hill. With a slew of new apartments coming online next year, Garvin said he expects rents in older buildings to level out.”

When housing demand is very high, it may not be possible to increase supply fast enough to completely turn around rising prices. But even in such cases, greater supply will keep prices lower than they would have been absent that increased supply, and that benefits everyone in the housing market, those on the lower end of the income spectrum in particular.

Still, some affordable housing advocates balk at the supply side because they know that even with limitless supply the private market cannot deliver housing at deep affordability levels. What they are missing is that it doesn’t have to be an either/or scenario: Supply and subsidy can be mutually beneficial. When supply keeps prices in check, it reduces the amount of subsidy required to make up the difference between market rents and rents that lower-income households can afford. The availability of new units also reduces competition for older housing, thereby helping to preserve that lower-cost option.

What those who are inclined to ignore the supply side are also missing is that trying to maintain sufficient affordable housing through subsidy when housing supply is constrained in a high-demand market is like trying to hold back the incoming tide with a broom. How much does suppressing supply aggravate affordability? Consider San Francisco:

Over the last 20 years, San Francisco has added an average of 1,500 new housing units per year— to keep up with demand, we should have built two or three times that many. The inevitable result is a matter of high school economics: With too few apartments and too many people, prices keep going up.

“That didn’t have to happen,” says Enrico Moretti, a UC Berkeley professor whose book, The New Geography of Jobs, argues that restrictive zoning and land-use policies are a prime reason for San Francisco’s housing affordability crisis. He likes to cite a study by economists at the University of Pennsylvania’s Wharton School of Business, which found that, of nearly 2,500 municipal areas across the country, San Francisco is the most restrictive large city of all. That’s no surprise to anyone who follows local politics, where every new development is subject to endless lawsuits, petitions, and NIMBY-funded opposition.”

Many Seattle policy makers like to point out that San Francisco has more stringent requirements on developers to provide affordable housing—including “inclusionary zoning” that requires low rent housing units in new development—not to mention rent control. The implication is that San Francisco is doing a better job than Seattle at tackling affordable housing, and therefore Seattle needs to catch up by emulating them. How’s that working out for ya down there, San Francisco?

What’s lacking in Seattle’s assessment of San Francisco is a recognition of the blatant truth that, with the exception of a tiny percentage of residents who are lucky enough to score a subsidized unit, San Francisco has failed spectacularly at maintaining affordability. And that has everything to do with neglect of the supply side. The suppression of supply has led to an increase in housing prices across the board that dwarfs any gains that may have been made through subsidies derived from “incentive” fees on development or inclusionary units. This is not an outcome a smart city would want to emulate.

Addressing the supply side means rezoning to allow greater development capacity, easing onerous development regulations, cutting fees and delays on permitting, reducing construction costs and developer risk, and generally allowing for more flexibility, options, and variety in the housing market. It also means having the backbone not to pander to naysayers who will always find some reason to oppose pretty much any proposed development project.

Requiring subsidized units or increasing the “incentive” fees charged in exchange for allowing the development of larger buildings are perfect examples of how to work against the supply side. In the best case, these requirements result in the production of a relatively small number of low-rent units with a commensurate price increase in the market-rate units, and that offsetting of expense from one unit to another does not make for a net improvement of overall affordability.

More typically, however, we can expect such encumbrances to constrict housing production because they undermine financial feasibility. Currently there are at least half a dozen proposed multifamily projects in South Lake Union that are opting to leave significant development capacity on the table because the “incentive” fees are in reality a disincentive. Again, when housing sites are underdeveloped, the sacrificed supply sets back progress on both affordability and sustainable growth.

And given all there is to be gained, do we really need to be worried about developers making money? If potential profits are high, it will attract more private developers into the game and more housing will get built, providing the dual benefit of putting downward pressure on price while also helping us meet our smart growth goals. If development is allowed to respond to the market, eventually supply and demand will move toward a healthy balance, and profits will fall accordingly.

As is widely recognized, even if the supply side is cultivated, subsidies will still be necessary to provide housing that is affordable to very low income households. Seattle’s affordability mission should be to establish innovative new funding sources for subsidy that (1) don’t restrain supply, (2) don’t favor existing residents over newcomers, and (3) don’t sabotage smart growth. Seattle’s Housing Levy and Multifamily Tax Exemption are good existing options. In contrast, taxing new development with “incentive” fees fails on all three counts.

I believe that one appropriately fair new tax revenue source for subsidizing affordable housing would be an additional assessment on single family homes. Seattle has about 2/3 of its land area zoned for single family houses only, which amounts to a huge constraint on increasing housing supply that pumps up prices across the board. Or how about a capital gains tax on the sale of land, which would have the added benefit of tempering land speculation? Seattle is overflowing with smart people. Let’s avoid repeating the mistakes of other cities, accept the challenge to think outside the box, and get this figured out.

Efforts to provide affordable housing are motivated by the desire to foster equitable access to all the valuable advantages offered by vibrant cities such as Seattle. But if the supply side is left out of the equation, you can be sure that equity is going to take the hit.

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Dan Bertolet lives in Seattle and is a socialist at heart.

Note: Gerding Edlen’s “Pine + Minor” market-rate apartment building shown in the photo above is participating in Seattle’s Multifamily Tax Exemption program. Twenty-three of its 111 total units are required to be rent-restricted. Sixteen of its 75 studios must be set aside for households earning less than 65%AMI at a total housing cost of less than $986/mo. Seven of its 36 one-bedroom units must be set aside for households earning less than 75%AMI at a total housing cost of less than $1,301/mo. The market-rate units are expected to rent for an average of $1,487 (studios) and $1,792 (1-bedrooms). Thanks to reader Mike Kent for pointing this out. It is also important to remember that the building is also playing a positive role for affordability in Seattle by simply providing new market-rate supply to help meet Seattle’s voracious demand for housing.

Frank, I think the only way to get family size units to be produced at any significant scale is through subsidy. Those units cost a lot more to construct, and if they are priced commensurate with their cost, most families couldn’t afford them.

In other countries families get a lot more government support in other ways (e.g. daycare, healthcare, leave, etc), which helps them be able to afford the larger housing units they need. I’ve hit on these issues before:

Excellent post, Dan. I can’t agree more that single family properties should help bear the burden of inefficient land use that perpetuates high multi-family costs.

But I’m not sure I agree that larger family units cost more to build than studios and one bedrooms. Bathrooms and kitchens are the priciest parts of a unit. As long as a unit has more livingrooms/bedrooms than baths/kitchens, its square foot construction cost should be lower than that of a studio or one bedroom. A 4BR/2bath should be cheaper per square foot than a 1BR/1bath…the bed to bath ratio is cut in half, and the larger unit only has one kitchen. Larger units do take a disproportionate amount of perimeter and circulation to build, and that’s also expensive. But then aren’t we back to equal?

Maybe someone who knows the math better could explain exactly why a larger unit is more expensive to build–putting aside the price each can command in the marketplace which is another issue altogether.

Heidi – yes, I agree that cost per sf may not be that different. But even if it is equal, that means a 3-bedroom would cost at least 3X a studio, which puts it up in the $3k per month range, which is not going to be very affordable to a family of 4 that earns the same as a childless couple.

I think the proof is in the pudding though. If there were plenty of people who could afford to pay enough rent to cover the cost of building larger units, then developers would be building those larger units. But they’re not.

This exchange between Heidi and Dan reflects a basic misunderstanding of how development decisions and housing pricing decisions are made.

Let’s say a developer could fit one 4BR/2bath unit into a certain square footage of a new building. Alternatively, the developer could put two 2BR/2bath units in that same space.

Certainly the 4BR unit is somewhat less expensive to develop than two 2BR units, for the reasons that Heidi cites. However, the combined rent that could be charged for those two 2BR units is more than could be charged for the single 4BR unit.

Dan then says, “I agree that cost per sf may not be that different. But even if it is equal, that means a 3-bedroom would cost at least 3X a studio, which puts it up in the $3k per month range, which is not going to be very affordable to a family of 4…”

This is not how rents are set. Rent is not charged based on how much it costs to build a unit. Rent is charged based on how much the market will bear. Developers seek to maximize their profits — i.e. the margin between their cost of production and the rents they can gain. That is why more small units are constructed. Even if the cost of production is somewhat higher to develop twenty 2BR units vs. ten 4BR units that occupy the same total square footage, the profit to be made is much higher from renting/selling the twenty 2BR units.

It is in fact true that a 3BR unit does NOT “cost at least 3X a studio.” That reality has nothing to do with the differential cost of production between the two units. It is because the market will not bear $3,000/mo 3BR apartments. Knowing this, the developer will decide to build three studios, rather than a single 3BR unit.

Thanks Dan, I see your point. At the very least I’d love to see more 2BRs and 3BRs being constructed. Even if they get gobbled up by 3 childless tech roommates in the short term, maybe over time as they become older units they’ll turn over and be available to a wider range of incomes.

Dan-
I find your ideas of additional assessment on single family home and capital gains on land sales interesting. This type of assessment might assist in addded cost of transit to less dense neighborhoods; be used to increase incentives to mitigate stormater or increase tree canopy as well as assist in funding housing. We do need better understanding of the economics to invest in the public infrastructure to support these developments. Funding thorough and open analysis of south lake union’s growth and value would be a start.

Dan, this is a very well written post. I’m perturbed that the City is taking the time to “study” affordability issues, but is entirely focused on solutions (higher fees, inclusionary, etc.) that will only compound the problem. San Francisco is a terrible role model.

What I have been saying has been falling on deaf ears: 1) study the impact of new housing on affordability over time (e.g, 1990’s new construction is today’s “affordable” market rate) and 2) assess the City’s affordability goals, especially for <50% AMI units, relative to available resources; if it turns out that we want more of those than we are willing to tax ourselves given existing leveraging opps, then change the goals to something more realistic.

Dan, you hit the nail on the head. We need to stop punishing those who help solve the problem with fees for creating more supply (developers of new multifamily housing). Meanwhile, the single family land owners are realizing incredible appreciation in this demand equation. This social burden needs to borne by everyone that benefit. Singling out new high density construction in urban/walkable/less car dependent locations is like asking a skinny person to go on a diet.
I also agree that the housing levy and MFTE are good carrots. I f we have more carrots we will need fewer regulatory sticks.

Why is the emphasis on “families” only? Why not some attention to single-person households? According to the 2010 US Census, more than 25% of US households consist of one person living alone. If I needed affordable housing, I’d love to rent a small studio, as it would help me live affordably in Seattle as a single person. You could also put more small apartments per building and get more of a return on investment than trying to create large apartments that are affordable.

Of course, many parts of Seattle exceed the 25% level. Here is a breakdown by zip code:

PROPORTION of Households consisting of ONE PERSON LIVING ALONE – Seattle Zip Codes (2010 US Census):

Could this household type be addressed? In fact, in a few of those zip codes, the MAJORITY of households consist of ONE PERSON living ALONE. It seems that if people want affordable housing, they would be willing to live in a small space to save money. Why not more studio apartments?

Seattle Planning Commission recently assessed Seattle’s affordable housing production and found it was falling well short of goals. Has a comparable analysis been produced recently by SF or any other city for that matter? Intuitively, I would guess SF probably is doing worse than Seattle, because housing production itself is relatively low there, but without real data in front of me, I don’t know. This post asserts that SF is not doing well but provides no evidence that it is doing worse than Seattle in providing for households in the lower income brackets.

As for ideas to consider, what if we prioritize and subsidize the permit process in areas like Rainier Beach, Othello, and Mount Baker station areas? (And don’t prioritize everyhting everywhere else, as is the ususal mistake.) What if Seattle pledged to cover the cost of street improvements for developments in a handful of priority areas in exchange for below market rents for a fixed number of years? What if the ‘green factor’ calculation could take into account affordability commitments (on the premise that high density affordable housing reduces stresses on the environment as much as green roofs do)?

Mark: totally agree that if we want private developers to cover the cost of producing affordable housing, then we need to offset that expense with incentives that actually are financial incentives. Upgrading streets is a good example. In contrast, the problem with granting extra capacity as an incentive is that extra density is something we actually want because it’s a public benefit in itself, so it makes no sense to put an extra fee on it.

Regarding SF’s affordability record, I’m just assuming based on the high average rents and the fact that there’s been relatively little new development, as you said. The data on how SF is really doing should be something that those who support adopting their affordable housing policies should be providing, but as far as I’ve seen, they’re aren’t.

I’m not sure I can get behind your assessment. To me low income housing is a dire need, and I don’t think you’ve made the case that simple “high school economics” supply and demand will give us a solution. Beyond the fact that the supply of low income housing is shrinking in a time when more of it is needed, the direness of the situation is there is less funding available for it and nobody is willing to build it on their own. Platitudes about finding these always enigmatic “innovative new funding sources” for housing subsidies don’t fix that problem.

So what are these “innovative new funding sources” for housing subsidies supposed to be? If you could answer that one then maybe you would have winning argument here. The reality is funding for low income housing is very hard to find (the low income housing supply is shrinking because funding for it is shrinking), so other ways have to be found to get it built. And that means policies that might be conflated with “restraining supply” or “sabotaging ‘smart growth'” (I apologize, but if there is a more Orwellian sounding buzz phrase than ‘smart growth’ then I haven’t heard it). I’m not sure that is avoidable anyway, regulation and growth are often at loggerheads in just about any market.

And just because regulation may be at loggerheads with market growth does not mean it isn’t necessary or is unwarranted. And when you get right down to it, in this age of deregulation and privatization that has returned us to the roller coaster of boom and bust economic cycles and extreme income inequality of the 19th Century, I’ll err on the side of regulation every time.

Besides, I’m not even sure you have the economics right. Sure, increased supply will help bend the skyrocketing cost curve, but it certainly won’t reverse it. And is anybody “worried about developers making money”? Admit it, you are just setting up a strawman there. When supply increases enough to the point where demand slackens and “profits fall accordingly” (where your strawman, no doubt, starts to jump with glee) is exactly the point where a developer will pull out and wait for demand to come back again (remember that profit is the goal of the developer, not affordable housing).

Herm, you give the impression that you didn’t read the piece very closely:

“Supply and subsidy can be mutually beneficial…”

“When housing demand is very high, it may not be possible to increase supply fast enough to completely turn around rising prices.”

“As is widely recognized, even if the supply side is cultivated, subsidies will still be necessary to provide housing that is affordable to very low income households.”

If you don’t think there are lots people hand wringing over developers making too much money, you haven’t been paying attention. The City’s current debate over setting the price level of in-lieu fees is essentially a debate over how much profit is acceptable for developers to make.

Sorry I wasn’t able to come up with perfect solutions for better ways to fund affordable housing subsidy in one blog post. Do you have any constructive ideas?

I think I read your piece close enough to understand what you wrote, I wasn’t attempting to contradict what you said. Look, my point was “constructive ideas” are hard to come by when searching for housing subsidies, and the importance of the housing subsidies can’t be overstated. And I’m sorry, but I am not the one advocating market deregulation and gutting current incentives so I’m not really sure why you are asking me for ideas. Is criticism that hard to take?

And you are right, I am not paying attention to any debate about in-lieu fees. I will refrain from commenting on it, but I still think this looks rather one-sided and won’t rule out the use of a strawman.

Herm, if you aren’t contradicting what I said, then that means you accept the idea that taxing new development is a counterproductive way to fund affordable housing subsidy. And it follows that you would be interested in finding other, smarter funding sources. I agree with you that it won’t be easy to find new sources. But I believe that if we keep doing what we’re doing now, we will never solve the affordability problem. So I would much prefer that we face reality and take on the challenge to figure out new solutions that would actually help achieve our goals.

No, you are being too cute by half. I think the shoe is on the other foot, you are not reading what I said very carefully.

As far as I can see taxing new development is the best way we have to fund affordable housing, and that will be true until you and others figure out another source. The important thing is that affordable housing continues to be built regardless of how it is funded.

What that means is I support taxing new development until a better way is found. And it has to truly be a better way, we don’t have enough affordable housing as it is so any new funding sources has to pass that benchmark. And as you point out in your own post, market deregulation is not the solution. Which is actually pretty obvious now 30+ years into this era of neoliberal “reform”. Deregulation, while promising much, just doesn’t deliver (unless you have deep pockets).

Rather than providing real solutions for things such as the need for affordable housing and limiting sprawl, deregulation in practice tends to be a force for sweeping issues under the rug. And I don’t see how your argument is any different in promising so much.

Herm: We already have a funding source that’s better, the Housing Levy, as I pointed out in the post (I first wrote about how it needed to be expanded back in 2009). This isn’t about deregulation or neoliberalism. It’s about understanding that housing is a system, that taxing new development may do more harm than good, and if so, we may be better off doing nothing.

Thank you for your statement that “The important thing is that affordable housing continues to be built regardless of how it is funded.” It perfectly illustrates the “can’t see the forest for the trees” perspective on this issue. For example, would it be okay with you if we funded affordable housing through new taxes on the poor?

It may make you feel better that a few lucky people get access to a subsidized affordable housing unit. But what you are ignoring is that the method of funding those units can actually result in a net rise in housing prices across the board, which hurts poor people hardest.

Supply Side, a new series addressing the interplay between development, regulations, housing supply, and affordability, and what it all means for creating the sustainable cities of the future. Or check out the C200 Series on why cities matter, and the S400 Series on solutions for cities.